When a company generates profits, it has several options on how to use them. One of these options is to distribute dividends to its shareholders, which is a way of sharing the company's profits with its owners. However, companies are not allowed to distribute dividends unless they have legally available profits to do so.
Legally available profit is the portion of a company's profits that is available for distribution to shareholders as dividends, after all the company's expenses, taxes, and other obligations have been paid. This means that a company cannot distribute dividends if it does not have enough profits to cover these obligations.
The concept of legally available profit is important because it ensures that companies do not distribute dividends that they cannot afford, which could lead to financial difficulties or even bankruptcy. By requiring companies to have legally available profits before distributing dividends, it helps to protect the interests of the company's creditors, employees, and other stakeholders.
To determine the legally available profit, companies need to prepare financial statements that accurately reflect their financial position and performance. These financial statements include the income statement, balance sheet, and cash flow statement, which provide information on the company's revenues, expenses, assets, liabilities, and cash flows.
The income statement shows the company's revenues and expenses for a given period, such as a year or a quarter. It provides information on the company's net income or loss, which is the difference between its revenues and expenses. The net income is an important component of the legally available profit, as it represents the portion of the company's profits that is available for distribution to shareholders.
The balance sheet shows the company's assets, liabilities, and equity at a specific point in time, such as the end of a year or a quarter. It provides information on the company's financial position, including the amount of retained earnings, which is the portion of the company's profits that has been retained for future use. The retained earnings are another important component of the legally available profit, as they represent the portion of the company's profits that has not been distributed as dividends in the past.
The cash flow statement shows the company's cash inflows and outflows for a given period, such as a year or a quarter. It provides information on the company's operating, investing, and financing activities, which affect its cash position. The cash position is important because it determines the company's ability to pay its obligations, including dividends.
Based on these financial statements, companies can determine their legally available profit and decide whether to distribute dividends to their shareholders. If the company has enough legally available profits